Saturday, June 6, 2009

About complimentarities, competition and open source

Perhaps the greatest joy of working in a multi diciplinary research department is that you get to rub sholders with great practicioners from other diciplines. By accident or design, I don't know, my research group which works on open innovation and open source shares office space with a group of hardcore economists wonks that spend their time making economical models to rationalize pricing decisions and how to relate to regulatory concerns. Despite the themes they are working on they are bright and plesant people, and from time to time I learn a few really interesting things from them, and I hope that goes the other way to.

In the interest of full disclosure: I am an unabashed Internet fanboy ;) I believe that internet players will eat the telco industry alive if it is given the opportunity. I am not the only one with this point of view in the telco industry, but it is fair to say that this view is not presently dominating. This is not the time nor place to elaborate on this but it is something to keep in mind when reading the text below.

Over the last six months there has been some discussion back and forth between our groups about the role of open source and software platforms in general in various situations, and I don't know if we have landed on a consensus or not, but there are some really interesting points that has come up that I would like to share with you:

It makes business sense to encurage lower prices on complementing services.

Complementing goods pairs of goods on which lowering the price of one of them will increase the sale of both. Egg and bacon, ham and cheese, phones and phone subscribtions are examples. Complementarity also extends to services. If you sell bacon it is very much in your interest that eggs are as cheap as possible preferably free, since that will increase the sales of egg and bacon. Of course, if eggs are totally free or if bacon is very expensive eggs may may become a substitute for bacon (at least as a protein source) so which goods are actually complementarities are very much post hoc classifications of observed behavior, not laws that are written in stone tablet. These things may change over time.

This is all very fine and compelling as an abstract explanation, but listen, it also perfectly explains why free and open source has been a good move commercially in some cases: Case in point: Sun Microsystem decided to give Java away for free. Arguably this saved Sun Microsystems from oblivion. Sun was, and still is, earning revenue mostly from the sales of server hardware. At the time when Java was made available for free Sun was facing fierce competition from Microsoft windows/Intel ("wintel") based software/hardware, market share was declining and something needed to be done. What was done was to kickstart an ecosystem of free (as in gratis) software that served as an alternative to the wintel platform. Software development tools are complementary to hardware, but they are not substitutes. By dropping the price of basic development tools very low, it allowed developers to develop software that worked both for wintel and for Sun and in a browser too, which was certainly better for Sun than having developers choosing one platform only, and then presumably chosing something other than Sun.

Complements can turn into substitutions

As indicated in the egg and bacon example above there are situations where eggs can become substitutes for bacon. This is certainly not the only situation where this can happen, the telecom industry in which I work is full of examples of complements that have or is slowly turning into substitutions. My favorite example is location. Phone companies has always had some idea about where the phones are located. This is true for fixed line phones but also for mobile phones. This means that phone companies have always believed that one of their unique assets is to know where their customers are. This was certainly true when GPS was introduced. The first GPS receivers I saw in the eighties were huge beasts intended for ship navigation. I believe it is fair to say that they complemented phone based location :-) At that time most phones were based on landlines. The fact that you knew where your ships or airplanes were in some cases made it necessesary to make a phone call, and the location of the caller might be useful in some way, but not to any great extent. In in no way did the refrigerator sized GPS boxes substitute for phone based location. Then mobile phones appeared and that changed the game somewhat. If you wanted to report where you were, it was possible to get the position from the phone company or your could get it from what was then becoming smaller sized GPS devices. In order to get your position from the phone company you had to enter into an agreement with them, pay for a subscribtion to a location service and the per lookup. In addition you had to grapple with less than well defined interfaces over strange communications protocols. It is fully understandable that GPS's well defined NMEA interfacing became the positioning technology of choise for solution developers. As time has progressed, the size of the GPS receivers have decreased. Today the SirfstarIII chipsets have unheard of sensitivity (-159 dBm) and without antenna it is the size of an adult's fingernail. GPS receivers are cheap, and they will only get cheaper. They are almost a checklist item in today's phones, and soon they will be in basically every phone sold at least in the western world. Nobody in their right mind is using telco based location any more. It is just not worth the effort when GPS enabled devices are ubiquitous. What was once a weak complement has now become a direct substitute, but it is actually even worse than that: The ecosystem of solutions surrounding location based services is almost exclusively based on GPS, so even in the cases where telecom positioning is a possible substitute for GPS, the telcos are not in a position to sell their services because the prospective buyers are just not interested.

So, a weak complement became a strong substitute. I asked my economist neigbours about this, was this something they had any appropriate theory for but they couldn't think of anything. I am not discuraged :-) I am sure there is relevant theory out there and when i hear about it I will incorporate it into this story.

What other complements can become competitors for telcos and what can be done about it?

In the same way that location was lost to GPS, what other presumably unique assets can we lose? Oh let me name the ways :-) VOIP is an obvious one: SMS/MMS being substituted by instant messaging (AIM, MSN, XMPP, ...). In fact, it its hard to think of a single basic product offered by telcos that cannot be directly substituted by something or someone. This seems obvious, but it is not really helpful since it really forces all participants into a Bertrand-style competition (a.k.a. "race to the bottom") where the prices will end up being dictated by the marginal cost of production. Another place to look is further up in the service stacks where the customer relationship is being formed and develped: There are many interesting opportunities, perhaps the most intertesting ones are based on social networking? What if telcos were able to both compete directly with the likes of Facebook, Twitter and Google for the attention and contexts of the users and to create products that mesh seamlesly into the services these other guys are offering, but at the same time sending some revenue to the telcos? It seems to me (and I have to admit this is something I heard from someone else that I unfortunately can't credit properly at this time :-( ) that this is a prime area where telcos can actually gain from participating in an open source effort: Identify some of the central tasks that the social networking sites needs to do in order to retain their business, define that as an area where the cost of using telco assets instead should be very low possibly free, invest in free or open source infrastructure to make it happen and be able to both defend income from existing services and to learn more about how to compete on equal terms with the social networking people for the user's attention and money. It's the same type of play Sun did with Java and it might just save us from being swallowed by the internet playes ;)

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